The Chairman’s Circle – Quarterly Call for Q3

TRANSCRIPT:

Marc Lichtenfeld:
Hi, everyone. This is Marc Lichtenfeld, Chief Income Strategist at The Oxford club, and I’m here with my colleague Steve McDonald, The Oxford Club’s Bond Strategist. And we’re here to talk about interest rates. Now, Steve, normally that’s kind of a dull subject.

Steve McDonald:
No, not dull to me.

Marc Lichtenfeld:
That’s true, not to you, and these days really not to anyone. It’s all anybody wants to talk about. Now, Steve, you and I, I think we have differing opinions on this. I see the lower interest rates and the inverted yield curve as signs of a possible recession, and I believe you don’t. Why is that?

Steve McDonald:
It’s not that I don’t see a possible recession. We have to have a recession. In fact, I talk about that with my bond readers every week. I say you must plan for the worst-case scenario. You must structure in such a way that you prepare for this because it’s going to happen. But is it going to happen this year or next year? You know, we haven’t had a negative growth quarter in how many years? And you need two quarters in a row to be a recession. Despite all of the drags from the trade talks, or tariffs, whichever you prefer… despite all the political turmoil, we’re still chugging along at 2% to 2.2% growth, which in this economy is very good. I mean, what’s China? 6.6%?

Marc Lichtenfeld:
Right.

Steve McDonald:
But at the size that we’re talking about and the momentum that’s in this economy, I just don’t see it happening right away.

Now, could we get into a situation like 2007, which most people don’t talk about, which preceded the 2008, 2009? But what caused the drop that drove everything down was a spike in oil prices. And in an interview recently with the Saudi crown prince, who’s running the oil business now, he said, “As tensions rise with Iran, we’re going to see a spike.”

So if we see that spike… game changer. It’s going to have to go up significantly. But if the Iranians sink a tanker in the Strait of Hormuz, or they close down the Strait of Hormuz, there are more drone attacks, they shut down the refining ability – it’s a situation that we must be prepared for. As a bond investor, or even a conservative investor, your dividend stock guys, these are things that we have to have protections in place for sure.

Marc Lichtenfeld:
So I don’t disagree with a lot of the things you said. My concern is that I believe that the markets are forward-looking indicators, so if rates are plummeting and the Fed is cutting rates, to me, that’s saying the market and the Fed know something is out there lurking. I don’t believe that the Fed is just being cautious, and I certainly don’t believe that Powell is being talked into lowering rates by the president, so the fact that that’s happening concerns me.

Steve McDonald:
I hope he’s not talking him into it. I mean, every time I see a tweet or something from Trump that says he’s putting pressure on Powell, I’m thinking, well, he can’t ignore all of it, but let’s hope he’s ignoring most of it.

Marc Lichtenfeld:
So yeah, I don’t believe that he’s being strong-armed into it. The fact that the yield curve is inverted several times does concern me significantly. And so, for me, the markets are speaking, and the Fed is speaking and telling us that there’s something out there. On October 1, the ISM manufacturing survey number came out. It was the worst since 2009. Now, that could be because of trade war. It could be a slowdown in Europe that’s impacting our manufacturing. But to me, I’m starting to see cracks in the armor, and it’s concerning me.

But one thing I want to touch on because you mentioned it. You talked about the bond industry and that you have to be prepared, and I look at the dividend stocks. So what do you expect from the bond market going forward in this low-rate environment?

Steve McDonald:
I expect it to continue to be difficult to find a good buy. In fact, we haven’t had a new recommendation in a couple of weeks, and there are a lot of new people, a lot of new readers, in Oxford Bond Advantage.

What do I expect? I expect the buying from Japan and the EU, where they had negative yields, to continue. I think that is the one factor in the low rates and the inversion that makes this a little different than it normally is. Because never when we’ve had a rate inversion, a treasury rate inversion, have we had the type of buying pressure that we’ve had from the EU.

I mean, every bond in Germany now is paying negative interest.

Marc Lichtenfeld:
That’s unbelievable.

Steve McDonald:
Think about that. I remember a couple of years ago we first started talking about this. I said, “Are they crazy?” They’re charging people to invest their money with the German government. It seems to be working because the people who did it two years ago made a killing.

Marc Lichtenfeld:
Yeah.

Steve McDonald:
Because the rates are just dropping again. So where do I think it’s going to go? I think we’re going to get hit with a black swan. I think the most likely will be oil prices. I think that will accelerate the possibility of a recession, and then I think rates are going to have to go up.

Marc Lichtenfeld:
Yeah. And when it comes to dividend stocks, there are not a lot of other places to go if you want to generate any kind of income, any kind of yield on your money, so I think dividend stocks will continue to be hot for that reason, and I hate that reason as being a reason to invest in dividend stocks. I want to invest in a company because I think it’s a great company, because their cash flow is growing – for all the right reasons. I don’t like the reason of there’s nowhere else to go. But I do think that’s kind of the place we’re in.

Last question. Should the Fed cut rates again?

Steve McDonald:
I never thought they should have cut the last two times. I think what we’re seeing and what the Fed is looking at is not pressure inside this country. I think the pressure and the reason they’re cutting rates is the slowdown in the EU, the slowdown in Asia. China, my God, is getting crucified. I heard some numbers the other morning. They were horrifying. Their manufacturing is way down, and I mean way down. And then you add into that the fact that the cost of manufacturing in China has gone up. People are moving into Vietnam. They’re moving into all other kinds of locations all over Asia. We’ve never been in this situation, so what’s going to happen? Nobody’s known that since 2009.

Marc Lichtenfeld:
Yeah, and I agree with you 100% that we shouldn’t have to cut rates, and if I’m right and the Fed does see something out there that is a cause of concern as far as recession, I’d rather take a little bit of pain and react to that rather than try to be preemptive in this environment. Maybe if rates were a lot higher, I’d be a little bit more agreeable to the Fed cutting rates preemptively, but there are not a lot of arrows left in the quiver…

Steve McDonald:
That’s the biggest problem right there.

Marc Lichtenfeld:
Should it hit the fan… And so, that’s what concerns me. I would like to see that they have the ability to act if things get really bad, and the more that they lower rates, the fewer bullets they have in the chamber, to mix my metaphors a little bit.

Steve McDonald:
My biggest concern about the Fed is in the 30 years I’ve been following it – that I’ve been in this business, 29 years… I don’t like to make myself older than I am – I’ve never seen a situation where the Fed didn’t overreact in both directions. ’94, oh my god. They crucified the market in ’94, and then everybody was running around going, “There’s no inflation, why are they raising rates?” Eight times in six months they raised rates. A couple of them were a half a percent. I mean, we’re not talking small things, so when they overdo it, they really overdo it.

Marc Lichtenfeld:
Yeah, that’s an excellent point. All right. That’s all the time we have. Steve, great to talk to you as always. Thanks, everyone, for listening, and we will see you next time.